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Whether a 401k loan is better than an IRA withdrawal depends on how large it is and whether it will affect your ability to qualify for the amount and type of mortgage you want. Of course, you’ll still have to pay federal and state income tax on the amount you withdraw from your traditional IRA. ❌ You may pay a penalty.401 withdrawals are automatically docked a 10% penalty. The IRS has very strict rules for qualifying for a hardship withdrawal. And if you don’t meet them, the funds you withdraw will be subject to income tax and a 10% early withdrawal penalty. Typically when you withdraw funds from a 401 before age 59½, you incur a 10% penalty.
Research what mortgages you may qualify for with lower down payments and whether you’ll qualify for home buying assistance. The federal government has many first-time homebuyer programs with lower minimum down payments and payment assistance programs. You should also check with your state’s local housing authority because each state has unique first-time homebuyer programs. These government-backed mortgages include programs for first-time home buyers and programs that target specific demographics. Even though sometimes it might be less costly to withdraw money from a 401, in many cases, it might be better to use PMI. PMI usually has an annual premium of around 0.5% to 1.5% of the principal amount.
Pros and Cons of Using a 401(k) to Buy a House
The money you withdraw from your 401K must be used specifically for the down payment. You may only withdraw the amount you need for the down payment – you cannot just keep the leftover funds. For example, if you must put $10,000 down on a home to purchase it, you may be able to withdraw $10,000 from your 401K. The only exception is if you need the money to pay the penalty and taxes on the money, which we will discuss below. Under normal circumstances, you cannot withdraw from your 401K until you are 59 ½.
Let’s break down whether you should make a 401 withdrawal to buy a home and other alternatives. A financial advisor can help you create a financial plan for your home buying needs and goals. A Roth 401 is an employer-sponsored retirement savings account that is funded with post-tax money. You can withdraw money from 401, but you will incur an early withdrawal penalty of 10% as well as taxes.
FHA Mortgages
You’ll enjoy the benefits of homeownership now and can look forward to paying off or selling your home to get ready for your retirement plan. While this option may be less costly than taking out a withdrawal, the interest on your loan repayment will have a cost. Information, rates and programs are subject to change without notice.
On the surface, a loan might strike you as a smarter way to go. You’re borrowing from yourself, so the interest you pay essentially goes back to you and not some bank. So long as you keep making payments, you won’t have any penalties or taxes to deal with. FHA loans require a minimum down payment of 3.5%, but only if your credit score is 580 or higher. If your score is between 500 – 579, then the minimum down payment is 10%. Rocket Mortgage®’s minimum credit score requirement for an FHA loan is 580.
Downside of Using Your 401(k) to Buy a House
You’re still able to withdraw up to $10,000 for the purchase, repair, or remodel of a first home without paying a penalty, but you’ll have to pay regular income tax on the entire amount. It's tough saving money for a down payment and closing costs. Many mortgage companies will allow you to use gifted money to cover part of all of your down payment and closing costs.
A large down payment is what makes a home purchase possible for many people. The more money you have invested in the property, the more likely you are to make your payments. What happens if you cannot come up with a down payment, though?
The penalties outlined above would apply for what’s withdrawn. However, your 401K account is ultimately filled with your money, and you can use it to buy a house, although doing so can result in a net financial loss. This is not a loan; it is a direct deduction of your 401K amount. This means you lose out on the interest and any other earnings you may have gathered by leaving the money in the account. It’s often a low, often no-cost option, thanks to the fact that you’re paying interest back to yourself. It’s no wonder so many homebuyers are thinking about 401 withdrawal to help with a home purchase.
Most homebuyers need to come up with a down payment, in addition to saving enough money to cover closing costs, moving expenses, and furniture for their new place. Your loan can be up to $50,000 or half the value of the account, whichever is less. As long as you can handle the payments , this is usually a less expensive option than a straight withdrawal. Though you will pay interest, you won’t pay taxes or penalties on the loan amount. That includes the compounding interest you could get from staying invested. You are borrowing from your future if you take out a loan and a withdrawal removes the opportunity for the money you could have left in your account to grow.
If you have not owned a primary residence in the past two years, you can withdraw up to $10,000 without incurring the 10% early withdrawal penalty (additional amounts have the 10% penalty). Other programs focus on specific demographics who may need assistance in purchasing a house. VA loans allow eligible veterans and service members to get a mortgage loan with no down payment. It also features low-interest rates and flexible mortgage terms. A USDA loan is another type of loan that allows people to pay less for a down payment.
• Conventional 97 loans are Fannie Mae-backed mortgages that allow a loan-to-value ratio of up to 97% of the cost of the loan. In other words, the home buyer could purchase a house for $400,000 and borrow up to $388,000, leaving only a down payment requirement or 3%, or $12,000, to purchase the house. • FHA loans are insured by the Federal Housing Administration and allow home buyers to borrow with few requirements.
If you take money out of your 401 before you’re 59 1/2, you’ll be hit with a 10% early withdrawal penalty. There are exceptions, but they’re very specific (death, permanent disability, dividing assets after divorce, etc.)—and buying a house ain’t one of them.3 That stinks. There are good reasons for not using your 401 to buy a house. Even if you’re comfortable with the 10% early withdrawal penalty, you will still be incurring long-term consequences by reducing your savings. Withdrawing or borrowing from your 401k is one way first-time home buyers can secure funding for down payments.
You will need to check, however, if your employer offers hardship withdrawals with your plan. They’re not required to offer either loans or hardship withdrawals. Keep in mind that you’ll be deducting mortgage interest on your taxes after you purchase your home. This may actually “wash” with some or all of the income you report from a retirement account withdrawal. I borrowed from my 401k once some years ago to pay college tuition for one of my kids. As I paid down the loan I reckoned this was a not so good deal.
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